Cloud computing gives Finance a Headache for Margin Management

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Submitted By: nmoriarty
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IT Infrastructure, Business Transformation, IT Architecture, IT Sourcing, Marketing, Forecast, M&A, Consultancy, Analysis, Buy-Side,

There is a self evident truth in trying to manage margins that, well, you’re dealing with two main measures in cost and price, so you need a thorough understanding of the real costs of the business to do it.  You can’t do margin management unless you know what it costs you to be in business.

For ‘traditional’ manufacturing businesses where there is a high fixed cost base, recovering the variable costs has usually meant building an overhead recovery plan based on sales volumes.  Particular problems might arise if your product is susceptible to commodity prices, but a decent approach to managing purchase price variances will pick it up.  Given they are relatively lower in scale, the variability of variable costs will be more than swallowed up by the calculation of gross margin and pricing management.

In that context, IT costs used to be a relatively ‘static’ cost that could be capitalised, and the costs even of an implementation project amortised over a long enough period to allow the impact of it not to affect operating margins too much.  Arguably though, the internet is changing that, through two factors:

  • With ‘cloud computing’ web-based services, more and more software becomes (a) easier to buy at low cost that may not be picked up by typical expense management models and (b) more is pushed into the ‘variable cost’ category.  So the balance of fixed to variable in the product cost changes.
  • The balance of activity in the overall cost model moves from ‘things’ to ‘people’ – the activities involved in order processing, customer service, shipping, after sales service start to represent a greater proportion of the overall cost, meaning that management policies and procedures need to be put in place where maybe they weren’t needed previously, to ensure accurate tracking of the actual costs of doing business.  As some (if not all) of these are often missed from product costs in the first place, the impact of getting it wrong simply multiplies.

This is more of an issue in service based industries, where the people costs of development can become a significant headache, trying to manage against some kind of time / cost / expenses model on a project-based approach.   Take for example the production of digital books, where the production model still has authors, illustrators, editors, graphic designers , specialist software etc, and all those people can be spread throughout the world by the power of the internet.  Little wonder that digital book producers have a hard time knowing what the costs of production actually are, which makes for an interesting discussion when most of the consumers in the world seem to believe they are being ripped off by the price of digital books at levels close to the physical printed copy.  Spare a thought for the Finance Directors of the world.

What this also does is push more businesses into being ‘people businesses’ where previously they weren’t, i.e. that the costs of people are starting to exceed the costs of product.  It’s long been recognised that the economics of people based businesses need different measures than product based ones, because slight shifts in productivity have higher leverage on profit and thereby shareholder returns.

In many ways, the tools have not yet caught up with this trend.  It could be considered to push the discussion towards the application of Activity Based Costing, which may be appropriate but is not everyone’s cup of tea, although it can help to track the costs of the activity whether or not they are built into product costs.

The difficulties lurk in the implementation of such principles where the devil is in the detail, when companies try to apply cost controls to the more ‘creative’ elements of the business that have never experienced it before, and opens yet another can of worms in trying to standardise and track people based activity, or introduce ‘lean thinking’.   Just how long should it take to produce a graphic design? And how do you get the rate fixer round when your worker is in Singapore, Hyderabad, Cairo or Mexico City?

One Comment

  1. pablojejcic

    Noel, very interesting post… I would say that cloud computing or service based solutions are a disruption to all IT models, and many business models in the environment/market.
    If you take it from the point of view that the different method of provisioning services in the cloud can drive different financial models to control cost/profit/revenue/margin; then you can get to the conclusion that each of this methods will provide a benefit to the supplier in many cases.
    Meaning, the lower the cost for the supplier to provide a service (doesn’t matter on what it is based) the higher the profit for the same level of revenue, general standard principle, but it changes in cloud related to how to measure it…

    sorry, just thought about throwing a bit more mud into the discussion… 😉

    Great topic for a long conversation though…

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